Taking a selective approach to European real estate

The same macro and geopolitical headwinds that continue to fuel market volatility, inflation pressures and shifting global dynamics have also compelled portfolios to diversify. And private market assets have been a notable beneficiary.

As many investors look to further refine their alternatives portfolios, the focus must now shift from broad diversification to more targeted sub-asset private strategies.

“As investors think through their private markets allocations, the backdrop upon which they make decisions is changing, or arguably has changed,” said Thomas Cheong, president of Asia Pacific and the Middle East at Principal.

Amid this re-evaluation, this selectivity is particularly apparent in real estate, rewarding those with a granular, sector-focused strategy.

In response, Principal’s real estate and private markets platform encompasses both public and private market capabilities across all asset classes. “This enables us to craft precisely calibrated solutions aligned with investment objectives,” Cheong explained.

It helps being among the top seven global real estate managers – with over 60 years of experience and US$100 billion-plus in AUM in real estate assets. Such positioning provides the firm with unique advantages in market access, deal flow and execution capability, according to Munirah Khairuddin, chief executive officer and head of Principal Asset Management Berhad (Group of Companies), and managing director, strategic distribution and institutional client relations (Southeast Asia and Global Shariah).

“This scale, combined with our sophisticated approach to real assets and corporate private markets, allows us to deliver differentiated value to investors’ portfolios,” she said.

In Europe, for example, while some traditional sectors like office space have seen mixed performance due to remote work trends, others are thriving. There is sustained demand and strong returns in logistics and industrial properties, driven by e-commerce and supply chain recalibration. Similarly, specialised sectors like data centres, hotels and residential are benefiting from long-term demographic and technological tailwinds.

“For investors, success in this environment requires a disciplined, sector-specific approach, and a focus on assets with strong fundamentals and structural growth potential,” explained Tan Yo-Hann, head of private markets for Principal in APAC and the Middle East.

With the window for an "early-mover advantage" likely to close at some point, those investors who act strategically now are still well-positioned for the future, he added.

Capitalising on key pockets of European real estate

After a structural re-pricing in the European real estate market due to a higher interest rate environment coupled with increased market uncertainty amid tariff announcements earlier in 2025, several areas of interest have more recently re-emerged for investors to consider.

“We are seeing increasingly positive investor sentiment,” explained Giles Smith, head of fund & product management for Principal in Europe. “The softening of yields across other asset classes makes European real estate look more compelling, plus renewed bank lending is supportive.”

The most attractive opportunities are in specific sectors and geographies. For example:

• Logistics – a preferred route for many investors based on growth in online/e-commerce activity in the retail space, along with nearly 60% of existing stock already over 10 years old and increasingly unfit for purpose. Further rising vacancy rates in some markets, especially the U.K., have led to a fall in new stock. And as occupiers get more specific with their needs, such as robotics-related facilities and, in Europe, with ESG criteria, the market might see a shortage of preferred stock in the next couple of years.
   
• Data centres – a relatively new asset class for the majority of real estate investors, being fuelled by favourable dynamics such as the proliferation of data creation and consumption, plus tightening supply and natural limits to supply growth in Europe.
   
• Hotels – as the global middle class population expands, Europe is an appealing destination. The high proportion (56%) of owner-occupied hotels across the region , plus development constraints and a changing service delivery model, create a promising outlook.
   
• Residential – opportunities exist as a result of a general supply/demand imbalance across diverse cities. More specifically, there is a relatively immature build-to-rent (BTR) market in the U.K. and a risk of regulation in markets like Germany and the Netherlands.

Across Europe, opportunities are also arising from the boost to defence and infrastructure spending.

With well over €2 trillion allocated over the next decade by the European Commission, Germany and the U.K. alone, investment and job creation will benefit key markets from the U.K. to France to Germany. Smith sees this as having a big supply chain impact from metals and engineering to electronics and commodities. “Development partners in Germany are already seeing government and military contracts.”

Meanwhile, there is also increasing momentum behind operational real estate (OpRE) strategies, as investors seek ways to maximise value, mitigate risk and hedge against inflation.

According to Smith, investors can find value across sectors as diverse as data centres, healthcare, purpose-built student accommodation, self-storage and hotels. “Demand is underpinned by strong thematics and evolving sectors, catering to the changing role of real estate in society with greater alignment between real estate and infrastructure in terms of barriers to entry, management teams and platforms, and long-term durable income streams,” he explained. “[OpRE] is also a proxy for exposure to sectors and thematics like artificial intelligence (AI) and data centres.”

Keeping up with data centre demand

Among the appealing European sectors, data centres have the potential to become the best-performing, driven by a third consecutive year of demand surpassing supply in 2025.

While development bottlenecks persist in core hubs, secondary and emerging markets continue to attract investment. More specifically, the Nordics and Southern Europe could be the primary beneficiaries of this trend, amid uncongested grids and shorter connection times.

In general, the investment case is stronger than ever. Considering already vast cloud and social media usage, combined with ever-increasing adoption of the internet and connected devices, Sebastian Dooley, a U.K.-based senior fund manager at Principal, foresees exponential growth in the coming years in digital data creation, consumption and storage. “This creates a secular mega trend of demand for more physical data centre space.”

The opportunity is supported by strong fundamentals, double-digit rental growth and vacancy rates trending to record lows.

“The data centre sector is a textbook example of a strong supply-demand imbalance,” added Dooley. “What makes this even more attractive are high barriers to entry as the electricity required for new facilities is simply unavailable. Hence, the gap between data generated and storage capacity is set to widen.”

Access for investors has historically focused on development, offering value-add style returns. Now, it is becoming more viable to get exposure to core, stabilised assets.

Dooley also highlights the longer-term opportunity, given that the operational challenges and required volume of capital expenditure from tenants means they tend to be sticky. They also perform rolling refreshes of their on-site servers. “This is an important risk reduction factor due to the financial commitment of tenants being similar to, or event larger than, an investor’s commitment,” he added.

Where Europe faces challenges, however, is the natural cap on how large assets can get. According to Dooley, in prime locations, especially those close to cities in tier 1 markets, the constraints on space and power are much greater. Further, the surge in AI adoption is driving a nuanced demand story.

Yet different approaches are emerging to mitigate the risks for continued growth. Among them is the concept of flexible design. For example, said Dooley, data centres can adapt to changing cooling systems. “Power risks can also be tackled through building redundancy, with 99.9999% uptime required.”

At the same time, modular construction and prefabricated building techniques can be a good solution. “Modular design is becoming key to address changes in specification going forward,” said Dooley.

And as investment shifts to secondary markets with better power availability, he is watching where the take-up goes. “Once availability zones are established, history has shown further take-up follows fast.”

Capitalising on the European advantage

Ultimately, Europe offers a diversification advantage for investors in real estate. This opportunity exists across markets – given differences between the U.K., Germany and Spain, for example – as well as in terms of supply side constraints, due to land availability, and in governance and legal frameworks.

At the same time, Smith highlights the consolidation opportunity. “A large proportion of European assets are held by private individuals and smaller investors.”

Reflecting the case for real estate in the region over the longer term, Smith pinpoints several sectors which could benefit portfolios, by having higher barriers to entry and being underpinned by strong thematics: data centres, logistics and residential/BTR.
 

Principal is a global private markets and real estate manager. Click here to read about where the firm is seeing investment opportunities.

The above insights were shared with clients in Singapore and Kuala Lumpur during two exclusive events held in late September to showcase Principal’s private markets and real estate track record and capabilities.

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